Revenue Growth – the Myth and the Temptation
What to know before you grow
Roger H Flaxman, Chartered insurance Practitioner and Insurance Claims Advocate gives examples ofthe unexpected consequences ofbrokers going for growth.
As every broker's management team knows the costs of running the business never seem to go down. Consequently brokers all over the country are putting themselves and their staff under relentless pressure to produce more income. This article addresses some of the unintended consequences of the drive for income and gives two recent examples of disastrous outcomes.
Revenue is not profit
It is a myth that sales growth (revenue) equals increased profitability. Very often the reverse can be true. Greater profitability can sometimes be achieved with less sales but more discerning sales. Many businesses have recognized thousand either sold books of business or hived it off to cheaper operating locations but there are still many brokers who are reluctant to lose any client so they blindly drive for pure revenue, oblivious to the elephant traps they are likely to encounter.
Pressure to perform
It is well known in our industry that many people are remunerated by results. "Results" usually means "bottom line", commission earnings, from whatever source. It is regarded as the quickest and easiest measurement of our performance; perhaps that is a matter for future consideration.
The pressure to "perform" does not, however, suit everyone's temperament and that is when the problem starts.
Straying beyond the skill base
As every broker knows client businesses under stress will often stray into taking on work with which they are not familiar and for which they lack the knowledge and skills. Some brokers take the same risk. They perhaps recognize a new opportunity to sell a specialist class of business and in the comfortable knowledge that they are perhaps CII qualified and have "read something about it" in the past they proclaim their new expertise. All goes well for a year or two and then one day a claim on one of the policies is refused by the insurers. The policyholder finds themselves uninsured and legal advice suggests, “sue the broker”. One of the processes that solicitors will go through when trying to prove a broker is at fault is to seek expert evidence from another experienced broker willing to make an "expert report" to a court of law.
An "Expert's" opinion
The " court's expert" is usually given a bundle of papers from the defendant broker’s files including correspondence, emails, proposal forms, statements of fact, demands and needs statements and other documentation that led to the policy being effected. In almost every case there is something in the "paper trail" of documents or, more probably, omitted from the paper trail, that gives an "expert" a reason to criticise what the defendant broker did or didn’t do. If the defendant broker is operating in his usual comfort zone of expertise and knowledge it is very often possible to overcome that criticism, but if the broker is operating in a new area the chances of surviving the criticism are considerably less.
In a recent case an SME broker placed insurances for a supplier and distributer of perfumes and fragrances. Amongst the insurances was cover for goods in transit and in storage with independent third party bonded and secure storage facilities indifferent parts of the world. In the first year of insurance the insured claimed for unaccountable theft losses of valuable stock to find that it was not covered. In the course of the investigation it was discovered that the broker had no knowledge of the specialist insurance requirements for the trade or of the conventions for the insurance of the carriage of goods and had not utilised the most appropriate available policies for the purpose. Amongst other things it was admitted (eventually) by the broker that they had been trying to build a new specialisation in the trade and were reluctant to seek more specialist brokers’ advice or services, to avoid competition. The broker's PI had to pay. It lost its credibility in the trade before it had really started. A broker that has been through an investigation of the kind mentioned above will know how intrusive, demeaning and demoralising it can be and will readily admit afterwards that it wasn’t worth the risk. Balance and the way to do it
There is of course a balance. Every broker is entitled to branch out and grow the business but time and preparation is required to become a specialist in anything and that in itself costs time and money. A well tried and tested way to become expert or specialist in a new field is to introduce business to a specialist broker and share the commission. The outcome will either be that there isn’t enough business to justify the initiative or that there is and there will come a time when the introducing broker will have gained enough knowledge and experience to be safe and competent to do it alone. Beware Insurers' Terms of Business Another pitfall for the unwary broker is in the contractual terms and conditions of Insurers who give authority to a broker to represent them. Insurance companies are themselves under extreme pressure to "grow" and will continue to offer superficially attractive deals to brokers to widen and strengthen their distribution resources. Sometimes expectations are not met. It is not uncommon for the insurer to find fault with the way that a broker is exercising its responsibilities under the agency agreement. This can be in a number of ways but is usually related to use of its binding or underwriting authority or to do with pricing and commissions. As remarkable as it may sound brokers will often sign the agreements without taking any legal advice and not fully understanding the implications of the apparently innocuous terms and conditions. When a dispute arises the common cry is, “I don’t think it means that, that’s not what I understood it to mean”. It must be said that the insurance industry as a whole is too casual in its use and acceptance of contracts. There are many reasons for this including the cost of legal advice, the commercial power of the big companies and the refusal to negotiate contractual terms and conditions – a take it or leave it attitude. There is also perhaps a misguided self belief amongst us in the insurance industry that we understand contracts because we deal in them every day. The fact is that as every contract lawyer will tell you there are always two ways of interpreting the same word, phrase or expression; yours and theirs.
In a recent case of this type a broker nearing the second anniversary of an agency agreement with a leading insurer was finding that business was dropping away because of new competition. The account executive responsible for the relationship with the insurer knew that unless a minimum income threshold was achieved by the second anniversary date the insurers would not offer renewal of the agreement.
The account executive took it upon herself (for largely self-interested reasons) to ensure that the income threshold was met. To do this she represented to potential customers that there are additional long-term renewal guarantee benefits. Infact these did not exist and were simply a ruse to get the business. The income was met and the contract renewed.
A year later customers started to renew with the expectation of the promises and representations that had been made by the broker and the misrepresentation came to light, in abundance.
The directors of the broking firm had no idea what had gone on despite being confident of their internal procedures and management supervision. There was no defence, period. The agency agreement was cancelled, claims were made against the broker by some policyholders and the insurer. The broker's uninsured costs exceeded more than three years’ average gross profit.
The temptations to take a chance, cut corners to cut costs and to venture out of one’s comfort zone and experience when under pressure are immense. Every broker can cite examples of even the biggest organisations coming under pressure to make growth and in doing so merging into failure or cutting costs and disregarding conventional wisdom believing they can beat the odds in the market. The larger organisations are more likely to survive, despite the error, than the typical Smirked.
Taking risks like the examples given above can be all the more dangerous because when things go wrong they are so public. They will attract the attention of the FSA, leading insurers and other industry organisations and there is often chance that the firm’s PI insurance and D&O insurances will fail to respond because there is a breach of warranty, material information or an exclusion which excludes so-called trading risks which many of these errors of judgement are regarded by insurers as being.
So what now?
So, you are reading this knowing that you too are under pressure and are tempted to branch out in order to grow. Help is at hand. The CII has recently launched a business mentoring scheme and there are independent business advisors with insurance industry expertise that are more than happy to sell you their time and expertise in preparing and planning for growing your business, profitably. Think of your business like your rose bush. Cut it back from time to time to make it flourish.